binv271828 (< 20)

Steve Saville: Why We are Gold Bulls

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This is another great article by Steve Saville. I have been having discussion recently on why I am a gold bull and a commodities bull. Oil is an inflation play and a strong inverse-dollar play. It has corrected very hard and is now a very good value for long term investors. Gold has not really corrected all that much. And if they are both the same play (inflation hedge / inverse dollar play), why not buy the one that has better value?

It is because they are not the same play. Gold is a currency (again, there are many divided opinions about this. Buty gold has served as money for more than 4000 years and has stopped being "offically" money for the last 40 years. I say gold has a pretty good track record, but it's your call), it is not a commodity and trades and behaves differently than commodities. There are similarities, but there are big differences too. And as such, gold has monetary utility. But monetary inflation and price inflation and inflation and inflation expectations are all different phenomena.

Saville has talk in the past about the lag in True Money Supply (TMS) growth and the perception of inflation in goods and services. A very good writing on the matter is here. Steve Saville: Market Value, Money and Credit. Please read this article first, which will give the one below has even more meaning.

The actions of the US Fed and Treasury between September and December of last year prompted fear in some quarters that the US was speeding towards a Zimbabwe-style hyperinflation. However, while we view hyperinflation as inevitable over the very long-term at no stage have we viewed it as a serious intermediate-term threat. In our opinion, the probability of the US experiencing hyperinflation within the next two years is close to zero.

We therefore don't believe that the threat of hyperinflation is a good reason to invest in gold today. We also don't think that the potential re-emergence, within the next 12 months, of what is commonly called "price inflation" is a particularly good reason to invest in gold at this time, although the prices of everyday goods and services probably will begin to rise in 2010.

To understand why we expect gold-related investments to do extremely well over the next few years it must first be understood that gold has never performed especially well (on a relative basis) during inflation-fuelled booms and has always performed very well during the busts that follow inflation-fuelled booms. Bob Hoye has done some good work on this topic covering hundreds of years, but we don't need to go back very far to see the pattern. Analysis of the past decade's market action will reveal that gold was a top performer during the mini bust of 2000-2002, generally lagged industrial commodities such as oil and copper during the major worldwide boom of 2003-2007, and then became the world's premier investment once the major boom transformed into a major bust. Looking at just the first half of this year we can see that gold started to weaken after hope of economic recovery -- the "green shoots" that everyone is talking about -- began to grow within the financial world. It is reasonable to expect, based on both history and logic, that the investment demand for gold will resume its upward march after this hope is dashed.

Now, just because gold has historically been a good investment during economic busts does not mean that it would be a good investment under the current monetary system if genuine deflation (a sustained contraction in the supply of money) were to occur. In fact, we strongly believe that gold would perform poorly if the government and the central bank stayed out of the way and let the money supply and prices collapse to their natural levels.

The way we see it, gold has been doing well and should continue to do well because of what governments are doing to PREVENT the natural flow of events from occurring. Whether officialdom is successful or not in propping up prices by creating new money and by transferring obligations from the private to the public sector is not the most important issue as far as an investment in gold is concerned. The most important considerations are that desperate attempts are being made, and will continue to be made, to divert the economy from its natural course, and that these attempts will cause additional economic problems and prolong the agony. This, and not the ultra-low-probability risk of hyperinflation or the relatively minor (at this stage) threat of so-called "price inflation", is the best reason to be bullish on gold at this time.

Although it doesn't mention gold, an article recently posted by Hans-Hermann Hoppe at http://mises.org/story/3449 touches on the main reason why gold should do extremely well over the years ahead if policymakers continue along their current path. The article explains that a general increase in the demand for cash is a rational response to increased uncertainty. The current situation, for example, is that people want to hold a lot more cash than they did two years ago because from their perspective the future is less certain today than it was back then. Moreover, the article explains that the hoarding of cash serves a useful economy-wide purpose in that it leads to a reduction in the general level of uncertainty and thus paves the way for a sustained recovery to begin.

Unfortunately, due to the fundamentally flawed thinking that dominates the halls of political power the general desire of people to add to their cash holdings is wrongly interpreted as something that must be fought against. Policymakers therefore attempt to dissuade the public from increasing its cash savings, and they do so by implementing various schemes designed to devalue cash and prop-up prices. But this causes uncertainty to remain at a high level, ensuring that the desire to save remains strong, and at the same time creates the incentive to save in terms of something other than the official currency. After all, governments and their central banks are effectively saying: "If you increase your savings in terms of our currency, we will punish you!" Consequently, people are driven to save in terms of a highly liquid money-like substance that cannot be depreciated by the government.

Actually, I think most people are underestimating the possibility of hyper-inflation. As the Fed prints money, interest rates have started to rise. Rising interest rates cause asset prices to fall, which counter-acts the asset inflationary intent of the money printing. This is particulary true in a heavily leveraged economy such as the one we have now. What has to happen for money printing to cause asset prices to rise is that the Fed has to print money faster than interest rates can rise. The only way the Fed can do this is to increase their money printing in a geometric progression, which is the definition of hyper-inflation.

Entrepreneur58, I agree with that statement over the long term. However right now the big reason why the Fed is printing money is for Quantitative Easing. The QE program is used to buy long dated treasuries (from, yep, the US Treasury) in order to put a floor under bond prices and keep rates down. Now this is a short term fix that only massively compounds the problem down the road. Because not only is this ridiculous on its face (creating money out of thin air by the US Federal Reserve to buy US Treasury Debt. It's not even robbing Peter to pay Paul. It is robbing Peter and giving Paul an IOU) it is sending massivly artificial signals to the market that risk is low (bond prices are typically a measure of general risk, and especially inflationary risk) while at the same time allows the Chinese and Japanse to unwind their massive US Long Term Treasury debt reserves for shorter term dated treasuries.

This will only compound the problem, and money money is printed to put a floor under bond prices and the true demand falls of a cliff. This game is only successful for so long. At some point the sham becomes too obvious to ignore and rate go the only way the can: UP.

There is no doubt a Treasury bubble. But I don't think it is going to pop yet. Because there are still too many people with most of the worlds wealth who are intrested in keeping that game going as long as they can. There will be a large unwind, but I think it will be relatively orderly for the near term.

However, I remain long term bearish on US Treasury Debt. Because I think stagflation and/or hyper-inflation are two very real and likely scenarios. Thanks for the comments!

Great post ... thanks! You have a terrific mind for both fundamental and technical analysis, and in their careful joining you have developed significant wisdom.

With respect to Saville's article, I agree that anything resembling hyperinflation may take a while to materialize... but I wouldn't place the probability of a more rapid progression at zero as he does ... there are simply too many factors in play to know for sure. I share your view about the likelihood of a more gradual and orderly unwinding event in long-term Treasuries, but again just add the caveat that some scenarios can be reasonably imagined where this progresses more quickly as well.

His clarification regarding inflation is very well received. If you don't mind, permit me to toss in an excerpt from my "top reasons for holding gold" article:

"6. Inflation Looms" "Of all the reasons to hold gold, the debate over potential scenarios for the onset of inflation remains the most unnecessary obstacle to understanding gold's outlook. We must not let the inflation debate muddy the waters for gold, since frankly, all scenarios are now supportive of gold. Whether you're convinced we'll see runaway hyperinflation, a deflationary spiral, or stagflation, the direction for gold is unaffected.

"Washington has shown its cards, Fools. A deflationary spiral clearly was deemed the most unacceptable consequence of this crisis, resulting in an implied guarantee that further economic contraction would be met by ever-increasing sums of stimulus. In this policy environment, therefore, inflationary forces do not hinge upon economic stabilization. While it's true that recovery could exacerbate inflationary forces as liquidity starts circulating through the economy, inflation can certainly take hold without it … and I believe it will. I view looming inflation as a currency event rather than an economic event, and see stagflation as a likely outcome. No matter which scenario unfolds, though, this environment is ripe for gold."

Hey Sinch, Thanks! I agree his estimate is conservative for inflation to show up, I personally think it could be sooner. But I agree 100% with your statements that all scenarios are supportive of gold. Even in a "defaltion" now. Because Washington will never let it be a true defaltion. Gold is the only true flight to safety now. It is abundantly clear to absolutely everybody now that the myth of the flight to safety into Treasuries is a myth.

I love all of your articles, but particularly the top 10 reasons! Great work!!

Greenspan is a historical member not to mention Tom Brokaw and several prominent Republicans.

There really does not seem to be much difference between Limo Libs and Big Gov Reps. However, there seems to be a very cozy club among the big wigs of both parties, elements of the media and major Corps.

I am not sure if this is a good reason to be long gold but I am not sure I like the idea of most major decisions being made by members of the same frat. There were a lot of foreign leaders also on the lists.

StopLaughing, LOL! Thanks man. Yeah, I guess I could think of a few more pertinent reasons to hold gold, but this is certainly part of the picture :). But yes, at the end of the day, these are the same people who want to "inflate us to save us". Gold is a sound currency in a world of currency devaluation wars. Thanks!.